The Office for National Statistics (ONS) announced today (14th May 2020) that the UK economy shrank by 5.8% in March. This is the largest monthly fall since records began in 1997 and economists are already saying that worse is yet to come.
That is because GDP measures monthly activity and March only had a single week of lockdown, while April was a full month and May is thus far two weeks of limited economic activity.
Extrapolating the past to what may come, has the markets nervous. And looks like there might be a good reason for that.
So what is GDP?
Gross Domestic Product is the measure of the “size of the economy”. If you add up the value of everything produced in a country during a particular period that gives you the GDP – and when compared to the previous period it gives you the rate of GDP – increase or decrease.
It tells us how fast the economy is growing (or not).
So if March GDP shrank by 5.8% it means that less stuff – products and services – was produced. And when it comes to production, more is better than less!
For those interested in the maths of how GDP is calculated;
GDP = C + I + G + (X – M).
- C is consumer spending – how much people in the country spend on goods and services.
- I is business investment – Businesses spend money to invest in their business activities.
- G is government spending – Governments spend money on equipment, infrastructure, and payroll.
- X is exports – product or service produced in the country and sold abroad.
- M is imports – product or service produced abroad and sold in-country.
What happens next?
As always with the economy, there are multiple points of view. There are senior economists who believe the UK GDP could fall further and that we will see a 25% fall from “peak to trough” – ie from when GDP was highest to its lowest point. Meanwhile, The Bank of England estimates a contraction of 30%.
Any which way you slice it, this is not good news for the economy and it’s clear that the longer the lockdown, the longer business activity is suppressed, the bigger the drop. If you look at the components of GDP you can see that if consumers slow/stop spending, if businesses slow/stop spending, if exports slow/stop as consumers and governments in other countries also slow/stop their spending; you can see a steep decline is coming.
The longer the coronavirus keeps us in this state of economic hibernation the longer GDP heads south.
GDP is an indicator of how the economy is performing. So while GDP itself doesn’t impact on you in any meaningful way, the movements of GDP will indicate what kind of impact is coming to you.
As we made clear above a drop in GDP will lead investors to consider whether they should invest or withhold capital. It leads companies to decide whether to hire/fire, invest or not and the consequences of those decisions ripple throughout the entire economy.
A swift economic recovery is probably optimistic and the best thing you can do in preparation for more bad news is budget like a boss, get your debt under control and get that emergency fund topped up as quickly as possible.
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